Capital gains relating to slump sale & Recent Developments

CA Chandresh Bhimani

Contents

• Modes of Mergers and Acquisitions

• Slump sale

- Concept

- Pre-section 50B position

- Section 50B - Overview- Section 50B - Overview

• Undertaking

• Cost of acquisition of Undertaking

• Slump Sale v/s Itemised Sale

• Slump Sale : Some issues

• Implications in the hands of the purchaser

• Recent developments

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April 2012

Merger / Demerger Acquisitions Others

M&A

Modes of Mergers & Acquisitions

AssetPurchase

StockPurchase Buy-back

CapitalReduction

SlumpSale

ItemizedSale

What is Slump sale

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April 2012

Concept of “Slump Sale”

• Slump sale means sale of an undertaking for a lumpsum consideration without assigning values to the individual assets and liabilities it comprises of

• The term “undertaking” includes “part of the undertaking” but whatever undertaking is transferred, it must constitute as a business unit to be carried on without any interruptionon without any interruption

• The consideration for such transfer may be discharged by transferee company in any mode

• Consideration is received by transferor company and not its shareholders

• Can be achieved through shareholder resolution and a business transfer agreement (timeframe : 1 – 2 months)

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April 2012

Pre-Section 50B - Position

• Transfer of undertaking as a going concern for slump consideration not liable to capital gains

- No taxation with reference to individual asset in absence of earmarked sale consideration

- No taxation for transfer of business as cost of undertaking and cost of improvement not ascertainableimprovement not ascertainable

- Charge fails in absence of support computation mechanism

• SC in PNB Finance Ltd (307 ITR 75) in the context of slump sale held as under:

“In this case, s. 45 applies. There is no dispute on that point. The first test is that the charging section and the computation provisions are inextricably linked. The charging section and the computation provisions together constituted an integrated code. Therefore, where the computation provisions cannot apply, it is evident that such a case was not intended to fall within the charging section, which, in the present case, is s. 45.”

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April 2012

Section 50B: Overview

• Section 50B introduced w.e.f. AY 2000-01 for computation of capital gains in case of slump sale of undertaking.

• Slump sale defined u/s.2(42C)

• ‘Undertaking’ defined u/s.2(19AA)

• Net worth of undertaking constitutes cost of acquisition

• Long term v. Short term determined w.r.t age of the undertaking

• Indexation benefit not available

• Report from an accountant which certifies computation of net worth to be furnished in prescribed form

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April 2012

Slump sale - Computation Mechanism

CAPITAL GAINS

SLUMP PRICE

MINUS

NETWORTH OF THE

TRANSFERRED UNDERTAKING

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April 2012

Net Worth of theUndertaking

Tax WDV of depreciable assets

Book Value of all liabilities

Book Value of other assets

minus

plus

Revaluation to be ignored while computing the Net Worth

Slump sale – Sec 2(42C)

• Section 2(42C) defines slump sale as

“slump sale” means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales.”

• Conditions to be satisfied cumulatively in order to qualify an arrangement as ‘slump sale’‘slump sale’

- There should be transfer of one or more ‘undertakings’

- Transfer should be as a result of ‘sale’

- Sale should be for a ‘lump sum’ consideration

- No values should be assigned to individual assets or liabilities in such sales

• Specific exception provided

- Determination of value of an asset or liability solely for the purpose of payment of stamp duty, registration fees or other similar taxes or fees not regarded as assignment of values to individual assets or liabilities

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April 2012

Slump price

• Sale for a lump sum consideration without assignment of values to individual assets and liabilities

• Factors supporting lump sum consideration

- Business valuation on DCF or yield method

- Valuation as a multiple of capacity, customer base etc- Valuation as a multiple of capacity, customer base etc

- Negotiated value for ‘the undertaking’

• Issues : Whether following impact the slump sale

- Absence of ‘assignment of individual’ values ‘in document of sale’ v/s.’ in transaction of sale’

- Reference in any collateral documents or evidences such as Board resolution, pre-sale correspondences exchanged; asset valuation report,etc [Refer, Artex Manufacturing [227 ITR 260(SC)]

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April 2012

Slump price

• Impact of separate valuation of Land and Building or intangible for payment of stamp duty / registration charges / sales tax

• Adjustment contemplated for working capital [Premium Automobiles (264 ITR 229(Bom)]

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April 2012

Undertaking

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April 2012

Meaning and scope of Undertaking – Sec 2(19AA)

• ‘Undertaking’ is defined in Explanation 1 to Sec 2(19AA) as under:

“For the purposes of this clause, “undertaking” shall include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.”

• Yallamma Cotton Woollen and Silk Mills Co Ltd vs Official Liquidator 40 Com Cas 466 while examining the expression “undertaking” in the context of “floating charge” Mysore HC observed as:

“undertaking’’ is not anything which may be described as a tangible piece of property like land, machinery or the equipment; it is in actual effect an activity of man which in commercial or business parlance means an activity engaged in with a view to earn profit.”

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April 2012

Undertaking

• Extracts from P. Alikunju, M.A. Nazeer Cashew Industries v. CIT 166 ITR 804 (Ker)

“Undertaking" in common parlance means an "enterprise", "venture", "engagement". It can as well mean "the act of one who undertakes or engages in a project or business" (Webster).………………..

• In R. C. Cooper v. UOI, (1970) 40 Com Cas 325 (SC), it was observed that

‘undertaking relates to the entire business although there may be separate ingredients or items of work or assets in the undertaking. The undertaking will therefore be the entire integrated organisation consisting of all property, movable or immovable, and the totality of undertaking is one concept which is not divisible into components or ingredients.’

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Cost of Acquisition

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Cost of acquisition - Net Worth

• ‘Net worth’ of an undertaking constitutes cost of acquisition

• ‘Net worth’ defined to mean aggregate value of total assets of undertaking (excluding revaluation) as reduced by book value of liabilities

• Aggregate value of total assets

- In case of depreciable assets : WDV of block of assets- In case of depreciable assets : WDV of block of assets

- Capital assets claimed deduction u/s 35AD : NIL

- Other assets : Book value

• Illustrative ambiguities

- Cost / book value of scientific research assets claimed u/s.35

- Cost / book value of scientific research assets for which weighted deduction claimed u/s.35(2AB)

- Cost / book value of Telecom license amortised under section 35ABB

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April 2012

Itemised sale vs. Slump sale

Itemized sale Slump sale

► Huge block of asset of other items and /or expansion plan for recoupment whereconsideration likely to get adjusted inblock of assets without giving rise toimmediate taxable income. (However,this may impact future depreciation)

► From the perspective of sales tax and stamp duty.

► Presence of high cost non depreciable assets where benefit of indexation or FMV substitution as on 1.4.81 is available.

► If rigor of section 50C is to be avoided.

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April 2012

substitution as on 1.4.81 is available.

► Transfer of obsolete / non-moving stock-in-trade / consumable likely to result in business loss.

► If balance sheet has certain non-depreciable assets which have lost value and are not likely to fetch any price.

►

Cases where section 50C or TP provisions etc permitting notional taxation is not a concern

► If appreciation is attributable to inventory or depreciable assets.

► Sales tax, stamp duty, etc is not a concern ►

If age of undertaking is more than 3 years whereas the age of valuable assets within it is less than 3 years.

Slump sale : Issues

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April 2012

Issue 1: Transfer of an undertaking having negative net worth

Transfer of undertaking

A Co B Co

Facts

• A Co sells its business undertaking having negative networth ( excess of acquired liabilities over and above the value of assets) to B Co

Issue

• What will be the cost of acquisition for the purpose of

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April 2012

Transfer of undertaking• What will be the cost of acquisition for the purpose of

computation of capital gains

Current Position

• Recent Mumbai Special Bench ITAT decision in case of Summit Securities – negative net worth to be added to sale consideration

• Contrary decisions rendered earlier Zuari Industries Ltd. [9 SOT 563 — Mumbai ITAT]a

Issue 1 : Transfer of an undertaking having negative net worth

Scenario A

Sale consideration 100

Less: cost o f acquisition (networth)

Aggregate value of total

assets

300

(500)

Scenario B

Sale consideration 100

Less: cost o f acquisition (networth)

Aggregate value of

total assets

300

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April 2012

Less: Value of

liabilities NIL

(200)

Capital Gains (restricted to) 100

(negative net worth ignored)

Less: Value of

liabilities (500)

(200)

Capital Gains [100 – (-200)] 300

Which of the scenario represents correct computation of capital gains?

Issue 2 : Transfer of business undertaking excluding certain assets / liabilities Test to apply : Whether buyer is put in position to continue the running business without the impugned asset?

Citation Exclusion o f asset

Premier Automobiles vs ITO (264 ITR 229)(Bom)

Transfer of manufacturing undertaking -sundry debtors not transferred

DCIT vs Mahalasa Gases & Transfer of manufacturing and distribution DCIT vs Mahalasa Gases & Chemicals (84 TTJ 992)(Bang)

Transfer of manufacturing and distribution undertaking - excess land, vehicle and debtors not transferred

Rohan Software (P) Ltd vs ITO (115 ITD 302)(Mum)

Sale of software business including intellectual properties,etc; exclusion of building and motor car does not defeatslump sale

Max India Ltd [112 TTJ 726] Transfer of manufacturing division -Technicalknow-how transferred in subsequent period; until that use thereof given on royalty payment

I.C. I India Ltd [23 SOT 58] Transfer of fertilizer unit - Bank balance, chequeon hands, unpaid insurance claims not transferred

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April 2012

Issue 3: Slump exchange

Consideration by way of shares

ABC XYZ

Facts

• ABC transfers B2 on a going concern basis to XYZ

• XYZ discharges consideration to ABC by way of shares

Issue

• Whether the transfer of undertaking for shares

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April 2012

B1 B2

Transfer of B2

• Whether the transfer of undertaking for shares taxable ?

Current Position

• Bharat Bijlee Ltd. (Delhi ITAT) - Transfer in consideration for shares would qualify as exchange and not sale, hence provisions of slump sale not applicable

• Since cost of acquisition not ascertainable, computation mechanism fails

Issue 4 : Other issues

• Does section 50C apply to slump sale covered by section 50B?

• Is section 50B a charging provision or machinery provisions?

- Impact on exemption under sections 47(xiii) /(xiv) or 47(iv)/(v) etc. which exempts capital gains chargeable under section 45etc. which exempts capital gains chargeable under section 45

- Whether exemption can be claimed under section 54EC / 54F

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April 2012

Slump sale : Purchaser’s consideration

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April 2012

Slump sale: Purchaser’s Consideration

• Purchaser entitled to allocate value of consideration to individual asset on fair basis including intangible assets acquired, depreciable assets, stock in trade, etc. [Shreyans Industries Ltd 277 ITR 443 (P&H) ]

• Business information, contracts, employees, and knowhow acquired in a slump sale - eligible for depreciation ?

- AREVA T & D INDIA LTD. VS. DCIT [2012] 20 taxmann.com 29 (Delhi)

• To safeguard against seller’s tax arrears / liability [S.281 / S.170]

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April 2012

Budget 2012

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April 2012

GAAR Provisions...

• Taxation of an “Impermissible Avoidance Arrangement” based on GAAR

• Broadly in line with DTC Bill

• Applicable with effect from April 1, 2012

• Very open-ended provision with widest discretion to tax authorities

• Review by GAAR “Approving Panel” of 3 Commissioners• Review by GAAR “Approving Panel” of 3 Commissioners

• Treaty override where GAAR invoked

• Threshold and guidelines to be prescribed by CBDT

• GAAR order directly appealable before Appellate Tribunal

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April 2012

...GAAR Provisions...

Arrangement to be “Impermissible avoidance arrangement” if fails to pass

Primary Test Any one of Secondary Tests

Creates rights/obligation unlike parties at Arm’s Length

Or

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April 2012

Main purpose or one of the

main purpose is to obtain tax benefit

Results in direct/indirect misuse/abuse of tax provisions

Lacks/deems to lack commercial substance in whole/part

Entered into/carried out not for bonafide purpose

Or

Or

Or

...GAAR Provisions...

• Tax consequence if GAAR invoked

- Illustrative list of consequences:

◦ Disregard/combine/recharacterise steps or parts

◦ Treat as if impermissible avoidance arrangement not entered into

◦ Disregard any accommodating party or treat any accommodating party and other party to be same

◦ Reallocate income/expense/deduction/relief/rebate etc

◦ Determine residence of a person/location of asset/location of transaction at place other than stated place of residence/location of asset/location of transaction

◦ Considering or looking through arrangement by disregarding corporate structure

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April 2012

Other key amendments...

Corporate Restructuring

• Fair market value of asset transferred deemed to be consideration where not specifically determined / ascertainable

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April 2012

Direct tax code bill, 2010

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April 2012

Slump sale under DTC

Provisions in respect of slump sale arrangements similar to the current provisions of the Act.

• Definition of slump sale similar to definition under the Act

• Includes division of a business

• “Net worth’ in relation to an undertaking transferred under a slump sale to

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April 2012

• “Net worth’ in relation to an undertaking transferred under a slump sale to mean value determined in such manner as may be prescribed.

• No specific definition of ‘undertaking’

• Clause 315 of the DTC Bill 2010 provides that any direction for aggregation of two or more items shall be construed also to include a direction for aggregation of negative and positive amounts in all their combinations.

Thank you